Cap Rate

In depth

Cap rate equals net operating income (NOI) divided by purchase price or market value. A property generating $20,000 NOI at $200,000 has a 10 percent cap rate. Cap rates vary by market, asset class, and risk profile, with low-risk markets producing low cap rates and risky markets producing high cap rates. Misconception: cap rate is not a complete return measure; it ignores financing, tax effects, appreciation, and capital expenditure. Practically, in seller-financed investment property deals, sellers and buyers use cap rate as a first-pass filter. Sellers offering financing often achieve higher prices (lower cap rates) because the buyer pool expands. Cap rates also help size potential rents on owner-finance properties to confirm cash flow viability. Multifamily and commercial buyers rely heavily on cap rate.